On July 2, 2018, the Securities and Exchange Commission (“SEC”) entered into a settlement with Houston-based global engineering, construction, and services company KBR, Inc. (“KBR” or the “Company”) over accounting issues that had led KBR to restate its earnings and identify a material weakness in its internal control over financial reporting in 2014. In the Matter of KBR, Inc., Admin Proc. No. 3-18569 (July 2, 2018). The accounting issues centered around the Company’s cost and revenue estimates and its calculation of “work in backlog,” a non-financial accounting metric the Company utilized. Without admitting or denying any factual findings, the Company consented to entry of the order, which included a $2.5 million civil penalty and found violations under Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1993 and Section 13 of the Securities Exchange Act of 1934, and numerous rules thereunder.
The SEC’s allegations piggy-backed on findings of the Company’s own audit committee, which determined that there was an inadequate control environment within KBR’s Canadian pipe fabrication and modular assembly business (“KBR Canada”). The SEC concluded that KBR Canada’s process for estimating costs to complete projects was not sufficiently rigorous, and did not actually reforecast project costs as new information was obtained. As part of the 2014 restatement, these issues had led to charges of $156 million, and the SEC agreed that the processes were inadequate. The SEC also concluded that KBR Canada had caused KBR to make improper use of “work in backlog” disclosures. Work in backlog represents the amount of revenue that a company expects to receive in the future from firm orders under already awarded contracts. In connection with certain KBR Canada contracts, KBR estimated that it would earn $400,000 per module at 20 modules a month, for total estimated work in backlog of $459 million, and thus included $459 million in its publicly disclosed backlog in the second quarter of 2012 and for six additional quarters. However, according to the SEC, KBR had not received —and the counterparty was not obligated to make — any orders under the contract, which led the SEC to allege that this was an improper use of the work in backlog metric.
In publicizing the settlement, the SEC focused on the “work in backlog” allegations, with the Director of the SEC’s Fort Worth Regional Office being quoted as saying that “non-financial statement metrics such as backlog can provide additional insight to investors regarding a company’s performance. . . . To the extent that companies disclose these kinds of metrics, companies must ensure they are accurate and not misleading.” Press Release, SEC Charges KBR for Inflating Key Performance Metric and Accounting Controls Deficiencies, No. 2018-127, U.S. Securities and Exchange Commission (July 2, 2018).
The matter serves as a reminder that companies need to ensure that their calculation methodologies match their representations. However, it also serves as a reminder that when a company is forced to restate earnings over accounting decisions, that restatement is often just the beginning of a long process, as the SEC’s order here came more than four years after KBR’s restatement.